venturousaustralia

building strengthin innovation

Venturing means enterprise and a major, bold and perhaps risky undertaking. It also connotes being forward looking and being prepared to seize opportunity. This is the innovative spirit we need to nurture in all Australians. An innovative Australia is a country that is enterprising and venturous.

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Senator the Hon Kim Carr Minister for Innovation, Industry, Science and Research Parliament House Canberra ACT 2600 Dear Minister, On 22 January 2008 you commissioned a Review of the National Innovation System. I have pleasure in forwarding the Panel's report to you. Innovation is not the problem; it is the answer. Innovation is not the opportunity; it is the imaginative response to opportunities. Our report identifies that the system requires renewal, refurbishment, recasting and where necessary re-imagining. We are entering an era when the global economy is being transformed before our eyes, with huge local implications. Innovation is pre-eminent in this transformation. New players are emerging, and around the world small countries like our own, which have already grown rich on the spoils of innovation, are renewing their commitment and redoubling their efforts. We need to take a long term view and respond with sound investments in terms of strategies for Australia. I would like to express my gratitude to my colleagues on the Review Panel who have worked with me on the Review, as well as those who have provided support to us during the Review. As we note in the Report, this document needs to be seen as just the start of the continuing national dialogue on innovation, and the wealth of submissions and material assembled during this project will remain very helpful in this ongoing process. I commend this report to you. Yours sincerely

Terry Cutler 29 August 2008

vii. overview

1. chapter 1 stalling not sprinting

15. chapter 2 the national innovation system

25. chapter 3 innovation in business

37. chapter 4 the case for a public role in innovation

45. chapter 5 strengthening people and skills

63. chapter 6 building excellence in national research

81. chapter 7 information and market design

99. chapter 8 tax and innovation

111. chapter 9 market facing programs

125. chapter 10 innovation in government

141. chapter 11 national priorities for innovation

149. chapter 12 governance of the innovation system

165. recommendations

181. appendix

201. glossary

annexes can be found on the website at www/innovation.gov.au/innovationreview and reflect the chapters above

contents

overview

We have known for several generations that innovation pre-eminently determines our prosperity. Yet innovation only began its prominence as a focus for Australian policy making in the 1980s. In addition to comprehensive policies to wean Australian industry off ad hoc production subsidies and trade protection, the Australian Government developed a range of policies to assist research and development and improve connections between researchers and business. These policies included the 150 percent R&D Tax Concession, Rural Research and Development Corporations and Cooperative Research Centres.

The backdrop for this study is provided by the confluence of four powerful circumstances.

Firstly, the architecture of Australia’s existing national innovation system is now a generation old. It requires reappraisal and the policies it comprises require renewal, refurbishment, recasting and in some cases re-imagining.

Secondly, the nature of innovation and our understanding of it is changing fast. In pursuit of a particular idea of innovation the 1980s policy framework sought to increase the supply and accelerate the commercialisation of research, scientific discovery and technological advances. Less attention was paid to improving the capacity of firms to apply the products of science and research, nor to understanding how boosting this capacity could better serve market and customer needs and secure productivity benefits for the Australian community. Commercialisation itself was generally understood to take place within a proprietary production chain largely closed to outsiders. Today innovation is understood to involve

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much more than the transmission of knowledge down the pipeline of production from research to development to application. In the age of the internet, with the opportunities for collaboration which it opens up, open innovation is increasingly important.

Thirdly, Australia’s focus on innovation policy intensified in the 1980s – after a prolonged decline in our innovation performance, and a commensurate fall in our relative prosperity. This policy focus bore fruit in sharply rising levels of R&D and other forms of innovation. However the rate of improvement has stalled over the last decade and some indicators suggest absolute decline. Furthermore, much of it appears to have been a response to our own policy decisions. As illustrated below, as a share of Gross Domestic Product (GDP), Australian Government support for science and innovation, has fallen by nearly a quarter. Also the number of researchers per 1,000 employees has declined substantially in the last decade, and US patents granted per 1,000 population have plunged from 0.06 to 0.01 (1999–2003). And yet during this time, the public revenue was fed by a torrent of cash from the mineral boom.

Figure 1: Australian Government Expenditure on Science and Innovation, 1993–94 to 2007–08, as a proportion of GDP

0.0%

0.1%

0.2%

0.3%

0.4%

0.5%

Shar

e of

GD

P

0.6%

0.7%

0.8%

DSTO

CSIRO

Other S&T Agencies

NHMRC & Other Health

Other R&D Innovation support

Industry R&DTax Concession

Higher Education Sector(including ARC)

CRCs

Rural R&D

Energy, Environment& Other Sciences

1994-951993-94 1996-971995-96 1998-991997-98 2000-011999-00 2002-032001-02 2004-052003-04 2005-06 2007-082006-07

Source: Victorian Innovation Economy Advisory Board, 2006

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Finally, the economic geography of global production is experiencing seismic shifts, with two great countries in our region – India and China – transforming themselves into economic giants. They are doing so by embracing openness and trade as we did in the 1980s. But we are observing far more than the phenomenon of economic ‘catch-up’. Innovation is pre-eminent in their self-transformation. Around the world small countries like our own which have already grown rich on the spoils of innovation are renewing their commitment and redoubling their efforts – countries like Finland or Singapore and Korea in the Asia Pacific.

The best summary statistic for our success in embracing new and better ways of doing things is productivity growth. Sometime around 2002 Australian productivity went from growing substantially faster to growing substantially slower than the Organisation for Economic Cooperation and Development (OECD) average. Though some of this may be an artefact of increased mining investment, it is unlikely to be the whole story. The conclusion is that, had it not been for the hunger the emerging giants of the developing world have had for our resources, we would have felt the effects of our complacency more directly as stalling living standards.

Figure 2: Components of Growth in Australian Living Standards

90

100

110

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130

140

150

160

170

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Labour ProductivityMulti-Factor Productivity

Inde

x: 1

980

=10

0

GDP per Person

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

Source: The Conference Board and Groningen Growth and Development Centre, Total Economy Database, January 2008, www.conference-board.org/economics/. Via Steve Dowrick.

This report stands for the proposition that we should arrest the slide in our performance and seize the opportunity that our recent prosperity gives us to begin building a more innovative and productive world in which our children will live, to which they will contribute, and which they will pass on in their turn.

http://www.conference-board.org/economics/

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An innovation action plan for Australia:Building the platforms; Exercising policy levers; Creating the connections

Entrepreneurial firms and innovative workplacesInnovation is about far more than the funding of research and science, or even of that and commercialisation. Australia thrives only if a critical mass of business enterprises and workplaces are consistently innovating – not just with next generation products, inventions and technologies, but in their operations, organisation, relationships and business models.

Business innovation today is not an easy thing to do and to sustain. We live in a connected, global knowledge economy, where ideas, capital and even people can be accessed with the click of a mouse. So what makes a business novel, distinctive, valued by paying customers and hard to copy really counts. Competing on innovation and knowledge is decisive to successful business performance for firms and to sustainable prosperity for nations.

It is vital that Australia is well endowed with innovative firms and workplaces. The key to this is deftly enhancing the opportunities and environment for business enterprises to innovate.

To do this we must be alert to the hidden realities of business innovation and the changing face of innovation that is no longer the province of the lone inventor or adept technologist. Innovation in the first decades of the 21st century is more open and pervasive, characterised by skill in collaborating and making connections so that knowledge flows and grows, and so becomes available to meet customer and community needs.

In such a world innovation policy is a central aspect of economic policy. This requires a significant recasting of Australia's innovation policy to give priority to strengthening innovation at the point where business enterprises and workplaces engage with their markets and customers. Reflected in recommendations for new business innovation and collaboration programs designed for productivity benefits, the end goal is nothing less than innovation-led prosperity for Australia.

Australia’s talent pool: Human capital and social networksKnowledge and skill – in modern jargon human capital – is at the heart of the rise of humanity. Increasing our knowledge and improving our skills is not just a foundation of our economic prosperity. It is also central to broader human goals and to the pursuit of happiness and satisfaction in our lives.

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High quality human capital is critical to innovation. Equipping our people with the skills to innovate is essential, not only for the generation and application of new knowledge, but also to use and adapt the knowledge produced elsewhere. Using the admittedly imperfect yardstick of the level of funds dedicated to public education, it is also an area in which our commitment has been waning, even absolutely as a share of our own economy, but far more emphatically so compared with other countries. For most of the post-war period Australia was one of the leading OECD countries in its commitment to education, as measured by the share of public expenditure. By 2003, however, Australian public expenditure on education had dipped to 4.7 percent of GDP, below the OECD average of 5 percent.

Building high quality human capital requires attention at all levels of education: from early childhood education and schooling, through vocational education and training and higher education, and into the workplace.

It is most assuredly the case that high quality education is about far more than funding, a point made vivid by the fact that we have doubled the resources spent on each child at school since the 1970s with scant improvement in measured outcomes. For this reason we acknowledge the substantial range of human capital reforms being progressed within our federation and, in this context, lend support to these reforms. Even so, it is imperative that our educational institutions do receive adequate funding and it is likely this will require a substantial increase in funding as a share of GDP.

We also recognise the importance of the human capital reforms currently in contemplation to the innovation reform agenda. These often span portfolios, jurisdictions, sectors and disciplines requiring carefully considered approaches and complex solutions.

Collaboration between all involved parties – something that cannot be delivered without a degree of bi-partisan consensus – will be essential if we are to adequately address the human capital challenges we face.

Information flows, market design and freedoms to innovateMarkets in which people compete for private gain can only come into existence against a backdrop of shared practices and expectations. Because these ‘rules of the game’ are a public good, governments are unsurprisingly involved in their provision and enforcement. Often the most efficient and innovative solution to an emerging problem is to develop a market – as Australia and other countries are doing with emissions trading.

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We can also alter the rules of the game to improve market outcomes. Information is crucial to functioning markets and is not well provided in many markets, particularly for expert services. Governments can improve information flows and support innovation and economic efficiency by encouraging disclosure, assisting markets for reputation to develop, and by ensuring that the information and other ‘content’ that they fund is freely available to maximise its use and the value that others can add to it.

Intellectual property is also critical to the creation and successful use of new knowledge – particularly the ‘cumulative’ use of knowledge as an input to further, better knowledge. In this regard, particularly in new areas of patenting such as software and business methods, there is strong evidence that existing intellectual property arrangements are hampering innovation. To address this, the central design aspects of all intellectual property needs to be managed as an aspect of economic policy. Arguably, the current threshold of inventiveness for existing patents is also too low. The inventive steps required to qualify for patents should be considerable, and the resulting patents must be well defined, so as to minimise litigation and maximise the scope for subsequent innovators.

Research capability and platformsAustralia's ability to generate strong productivity gains requires that we perform nationally important research and that we successfully adopt and adapt 98 percent of innovative ideas that are generated in the rest of the world. This Review calls for an urgent restoration of public funding levels for research in universities and government research agencies. It calls for the adoption of full funding for the costs of research at universities and increased funding for universities and government research agencies such as the Commonwealth Scientific and Industrial Research Organisation, the Australian Institute of Marine Science, and the Australian Nuclear Science and Technology Organisation, so that by 2020 we match the top quartile of OECD countries in public expenditure on research and development. A strong and sustainable public research sector requires universities to be providers of research, not investors in research.

Currently research in universities is not fully funded under competitive grants programs such as the Australian Research Council (ARC) and performance-based block grants, and so it is typically subsidised from universities’ other revenue streams, most particularly from the teaching of full fee paying overseas students. This cross-subsidisation of research from teaching profoundly undermines both activities, the former by short-changing it, with the upshot of leaving it subject to the uncertainties of international markets, and the latter by undermining its international competitiveness.

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We should accordingly move towards full funding of research. But this should not be at the expense of current success rates in ARC competitive grant schemes which are already under-funded. Neither should there be a contraction in the range or depth of research projects funded. Funding the full cost of research will accordingly require significant additional funding over time. However, because there has been a significant decline in the level of government support for research as a share of GDP over the past twelve years, the extra funding would do little more than allow ‘catch up’ with other OECD countries.

It remains the case that a significant portion of research funding should be aligned with national priorities as they emerge. Currently, carbon abatement and water conservation are good examples but priorities can change dramatically over relatively short periods of time, so flexible and proactive funding mechanisms are essential. We must also ensure that our most globally competitive industries, such as mining, agriculture, education and tourism, receive adequate research funding support to keep them at the cutting edge.

Transforming and rationalising tax incentivesSince its inception the R&D Tax Concession has been subject to several problems. Instead of being tackled directly in the design and funding of the central concession, those problems have typically been tackled by establishing additional programs.

While the Concession offers no benefits to firms until they are in tax profit, many of Australia’s most innovative start up firms remain cash strapped and in tax loss for many years. The R&D Tax Offset was established to deal with this, effectively providing cash to tax loss companies, but it remains hemmed in by very tight targeting to small firms.

The assistance the Concession has provided has also varied with the tax rate. With the reduction in the rate of concession from 150 to 125 percent, the Concession provides relatively low levels of assistance and not surprisingly this strongly constrains the extent to which it induces additional business R&D. Further, the Concession is accounted for ‘below the line’ and so is often invisible in company financial decision making.

As one of the Review’s roundtable participants put it, the concession is 'underpowered and overcomplicated'. We need to tackle these perversities.

The Review proposes the transformation and rationalisation of the suite of available tax concessions. The International and Premium schemes should be terminated and the basic concession increased and recast as a 40 percent tax credit.

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For small firms we propose increasing the rate of assistance further, as well as lifting the turnover threshold which defines ‘small firm’ tenfold – from $5 million to $50 million – and removing the expenditure threshold on R&D altogether.

These changes would transform incentives for business investment in R&D.

Market facing innovation programs Firms and people are fundamental to successful innovation. Government has an important and strategic role to play in facilitating this innovation where it is confident, firstly, that there are structural impediments to markets doing the work and, secondly, that government involvement will generate more benefits in addressing these problems than it will generate in collateral costs.

One mechanism is the provision of direct market facing programs to support innovative firms. Program assistance should be coordinated and targeted to the various identifiable stages of an innovative firm’s life.

The current suite of government market facing program assistance should be designed to focus on:

building the capacity of firms to absorb and incorporate new •knowledge;

facilitating collaboration – especially between firms and •universities and publicly funded research agencies; and

improving capital market development.•

To help firms build capacity to absorb and incorporate new knowledge, a new program to assist innovative firms in the high-risk early stages of proof-of-concept and development is required, together with an expansion of the Enterprise Connect program to build innovation performance and capacity in firms, and to allow access by services firms.

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The Cooperative Research Centres (CRC) review emphasised the value of collaboration for productivity and recommended the maintenance of a portfolio of collaboration and linkage programs and the reconfiguration of the CRC program with additional funding. In addition to the portfolio of collaboration programs, we recommend the introduction of an innovation voucher system to facilitate linkages between small and medium sized enterprises and the research community.

There is a global and systemic funding gap in the availability of capital for early stage ventures and thus the maintenance and extension of the Innovation Investment Fund and Pre-Seed Fund programs supporting capital raising by early stage companies is essential. To further strengthen the growth of high technology and innovative service-based firms, support should be given to organisations of angel investors to help increase networking and the Commercialising Emerging Technologies (COMET) program should be continued.

Any development of the venture capital market must proceed from a basis of full information. Such data has only recently been collected in a disaggregated level necessary for appropriate and reliable statistics to be available. To maintain the required level of data for the effective tracking of the venture capital market, the Australian Bureau of Statistics (ABS) needs to be appropriately resourced.

Innovation within GovernmentOne of the enduring advantages markets have over governments is that innovation can come from anywhere. CEOs of large companies and individuals running their own businesses are each free to improve what they do, and if they lower costs and/or better satisfy consumers, they have a good chance of being successful.

Government retains hierarchical authority structures. With many policy innovations to their credit, Australian governments have typically performed well at engineering top down innovation. But at the ‘coal face’ they have been less good at harnessing the insights of officials further down the chain of command and consumers of government services.

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In the age of the internet, and indeed of Web 2.01, there is less excuse than ever for governments not to do all in their power to cultivate innovation from the ‘bottom up’. Yet the very nature of what governments are seeking to achieve determines that their efforts must be experimental and exploratory. For this reason we recommend a suite of low cost measures to inculcate a culture of innovation in our public sector from the bottom up.

They include:

A body to operate as;•

an advocate for those within the public or private sectors who •seek to innovate but who are stymied by government culture, practices, structures, or regulation.

a source of funds and skills for the development of innovative •approaches to public policy and/or service delivery, the running of randomised policy trials and government tendering that maximises the scope for innovation in supply of goods and services to government.

The use of the Council of Australian Governments (COAG) reform •payments to make the most of our federation by encouraging a virtuous circle of innovation, experimentation and evaluation amongst the states and territories, which will help us learn what works and what does not.

National Innovation PrioritiesA key task for this Review was to identify a set of National Innovation Priorities to complement the broad National Research Priorities already in effect. To this end, the Panel engaged in widespread consultation with industry groups and other parties around the country. From this it classified areas for attention in terms of:

areas under the direct control of the public sector; and1.

areas whereby public innovation could spillover into 2. complementary private sector innovative efforts.

The list of priorities identify specific areas that would leverage Australia's distinctive geography, economy and capabilities.

In terms of the public sector priorities we identified the following areas: agricultural and food security, climate change mitigation and adaptation, population health, solutions in tropical environments, and applications to utilise broadband infrastructure (especially in health, education and public data access). In terms of stimulating

1 Web 2.0 is a term describing changing trends in the use of World Wide Web technology and web design that aim to enhance creativity, information sharing, and collaboration among users. http://en.wikipedia.org/wiki/Web_2.0

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complementary private sector innovation, the following areas deserve attention: resource industries, space and astronomy, finance and risk management, and marine industries. To manage and coordinate these priorities with those for research in public innovation programs, it is recommended that the proposed new National Innovation Council (discussed below) be charged with ongoing evaluation and identification of synergies across programs.

Institutional alignmentThe Review process has demonstrated shortcomings in the institutional framework that underpins the innovation system. There is a lack of policy coherence reflected in a fragmentation of innovation resources across government and between state, territory and federal governments. There is a focus on the short term in resource allocation.

A new institutional framework is required to enhance leadership and improve coordination across the innovation system. Such a framework needs to span ministerial and jurisdictional boundaries and encompass a broad range of policy areas. It needs to focus on coordination without centralisation, due to the importance of maintaining specialised roles and functions across the system.

To achieve the coherence, flexibility and responsiveness necessary for effective innovation policy, the system requires a 'central brain'. To fulfil this role a new National Innovation Council (NIC) is proposed. The Council would be charged with taking a helicopter view of the innovation system and providing strategic leadership. It would oversee the broad innovation agenda recommended by this Review. Chaired by the Prime Minister, it would replace the current Prime Minister's Science, Engineering and Innovation Council (PMSEIC) and would be supported by a high level Office of Innovation Assessment.

Governments must also improve the execution and coordination of operational program delivery. To maximise the impact of public investment in innovation, governments must work in a complementary way. To achieve this, the Review has proposed a framework of principles for innovation interventions for adoption by States and Territories, as well as the Australian Government.

Finally, improved data collection and better monitoring and review are crucial. Innovation measurement and research capabilities need to be strengthened. Mechanisms to ensure rigorous and consistent evaluations of innovation programs must be developed. The capacity to do this would be enhanced by the establishment of a National Centre for Innovation Research to advance knowledge of the innovation system.

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Conclusion: Venturous AustraliaVenturing means enterprise and a major, bold undertaking. It also connotes being forward looking and prepared to seize opportunity. This is the innovative spirit we need to nurture in all Australians.

At a time when the importance of innovation to our prosperity is clear, this Review has provided the Australian community with a wonderful opportunity to shape the future innovation landscape.

The Panel has been impressed by the enthusiasm of participants in the Review process and delighted by both the quality and quantity of contributions made.

The breadth of the task of looking across the entire national innovation system was somewhat daunting. The Review received over 700 submissions, and conducted a series of roundtable seminars on specific issues. Pressures of time and space in the report have prevented us from fully reflecting all of the excellent material and input received. We have, however, attempted to capture most of it in a series of annexes that will be published on the internet. Some of these annexes include suggestions for further action in specific areas, which will be brought to the attention of relevant parties.

We have enjoyed the opportunity to hear and discuss the many and varied ideas on how the national innovation system could be improved in order to meet the challenges facing Australia, both now and into the future.

Figure 3: The innovation landscape

GOVERNANCE &INSTITUTIONAL

ALIGNMENT

SUPPORTINGINFRASTRUCTURE

NATIONALINNOVATIONPRIORITIES

MARKET DESIGNand REGULATION

AL

GN

IIN

Information flowsand freedomsto innovate

Globalintegration

Australia’stalent pool:

Human captial andsocial networks

Entrepreneurialfirms and innovative

workplaces

Globalnds

and ftot i

lGlGl bobal

SUSTAINABLENATIONALPROSPERITY

and WELLBEING

Source: Terry Cutler

So now is the time to shape our national innovation system to ensure that it enables us to meet all the challenges we face. We will know we have succeeded when:

Productivity is again growing above the average of high income •countries;

Our people and workplaces are well equipped with the skills to •innovate;

Increasing numbers of Australian businesses are investing in •innovation to secure their competitive future;

Consumers are sufficiently well informed to demand the highest •standards with firms innovating to meet them;

Those with new ideas feel they have the freedom to develop them.;•

Australian businesses and research organisations are actively •involved in international collaboration;

Australia’s innovation system is properly coordinated and •integrated with our national innovation priorities;

The cost of research is fully funded in Australian tertiary •institutions, which also face strong incentives to specialise in research excellence;

Research and development tax incentives are rationalised and the •basic concession increased;

Markets are better enabled through the improved flow and •transparency of information;

A new culture of innovation is embedded within the public sector; •and

There is a single body effectively coordinating the innovation •activities of public sector research agencies.

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stalling not sprinting

Australia is a prosperous country. We have a high standard of living, we have rich resources and we have a highly educated population. We have a reputation for being inventive and we have successfully overcome the problem of being a large isolated continent separated from many of our trading partners. It is clear that our national innovation system has been pivotal in delivering economic success in the past, but today it is being reshaped by the confluence of four powerful circumstances.

Firstly, the architecture of Australia’s system is now a generation old and, in many respects, out of date.

Secondly, the nature of innovation and our understanding of it are changing fast. In the 1980s, the policy framework was designed to accelerate the commercialisation of research, scientific discovery and technological advance. Less attention was paid to improving the capacity of firms to apply science and research to secure productivity benefits for the nation. Today, innovation is understood to involve much more than just the transmission of knowledge down a pipeline from research to development to application. In the age of the internet, with the opportunities for collaboration which it provides, open, collaborative innovation is increasingly important. The internet has meant distance is no longer such an impediment, and we need to take advantage of it in transforming ideas into clever goods and services at a faster rate, in having a population as skilled and knowledgeable as our competitors, and in enhancing our lifestyle and protecting our environment.

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Thirdly, Australia’s focus on innovation policy intensified in the 1980s after a prolonged decline in our innovation performance, and a commensurate decline in our relative prosperity. This focus bore fruit in sharply rising levels of R&D and other forms of innovation. That rate of improvement has stalled over the last decade and some indicators suggest that there has been an absolute decline recently. As a share of GDP, public support for research and development (whether private or public) has fallen by nearly a quarter and public expenditure on education has slipped below the OECD average.

Lastly, the two most populous countries in our region, India and China, are transforming themselves into economic giants. They are doing so by embracing openness and trade, as we did in the 1980s, and through a strong commitment to innovation. In fact, innovation is central to their self-transformation. This is more than economic ‘catch-up’; these countries are becoming leaders in innovation in many fields. Many developed nations, like Finland, Singapore and Korea, have responded by increasing their innovation effort. Australia must do so too or see our relative prosperity decline.

Despite, these concerns, Australia remains one of the world’s most prosperous industrial economies, as can be seen in Figure 4 which displays real GDP per capita for 30 countries in the OECD.

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Figure 4: GDP per capita in 30 OECD countries, 2007

0 10.000 60.00020.000 30.000 40.000 50.000

Turkey

Mexico

Poland

Hungary

Slovak Republic

Portugal

Czech Republic

South Korea

New Zealand

Spain

Greece

Italy

France

Japan

Germany

United Kingdom

Finland

Belgium

Sweden

Denmark

Canada

Netherlands

Iceland

AustraliaAustria

Switzerland

Ireland

United States

Norway

Luxembourg

GDP per capita in 2007 - PPP$

Source: The Conference Board and Groningen Growth and Development Centre, Total Economy Database, January 2008, www.conference-board.org/economics/. via Steve Dowrick.

Australia has the 7th highest average income per person and this was attained through strong innovative performance, initiated in the 1980s and consolidated in the 1990s, in parallel with key policy innovations that resulted in the liberalisation of trade, deregulation and privatisation. Australia became one of the fastest growing OECD economies in terms of productivity and, even when productivity growth slowed, the economy was buoyed by strong growth in the terms of trade between 2003 and 2008. It is an enviable record and regarded by some overseas as a ‘miracle’ after the difficult economic circumstances of the 1980s.

http://www.conference-board.org/economics/

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Composition of the Australian EconomyThe structure of Australia’s economy has changed markedly in the last three decades. Our productivity growth has been very concentrated in particular sectors. Service sector industries have come to dominate, with a higher share of output than in some other advanced economies, while the manufacturing sector has been in decline. Finance, property and business services have increased their share from 14 to 21 percent while the manufacturing sector share of output has declined from 19 to 11 percent of output between 1975 and 2007 (see Figure 5).

Figure 5: Sectoral composition of Australia’s output, 1975 to 2007

Per c

ent

of t

otal

out

put

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

E lectric, Gas & Water

Manufacturing

Wholesale, Retail, Accomodation & Restaurantts

Transport & Communication

Finance, Property & Business Services

Government, Education & Health

Other Services

Mining

Construction

Agriculture, Forestry & Fishing

1975 1980 1985 1990 1995 2000 2005

Source: Victorian Innovation Economy Advisory Board, 2006

Australian productivity growth has been much more concentrated than other countries over the past decade and has come principally from service sector industries.1

1 Alan Hughes and Vadim Grinevich, The Contribution of Services and Other Sectors to Australian Productivity Growth, 1980-2004, report prepared for the Australian Business Foundation, 2007

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Investment in human capitalThe most fundamental drivers of innovation are the skills, knowledge and attitudes of the workforce – collectively referred to as the human capital of the nation.

A major shift in educational attainment levels occurred in Australia over the decades of the 1970s and 1980s – particularly for Australian girls. The proportion of boys staying on at school to Year 12 roughly doubled in the twenty years from 1970, from 35 percent to around 70 percent, whilst the proportion of girls staying to Year 12 more than trebled over the same period – from 25 percent to over 80 percent. Retention rates have largely stabilised since 1990.

Rising school retention rates were matched by rapidly rising rates of achievement of tertiary qualifications. By 2003, 40 percent of young women and 34 percent of young men aged 25-34 had achieved tertiary qualifications. This level of attainment is slightly below that of the USA and slightly ahead of attainment in the UK.1 This is an achievement we can be proud of.

The OECD Program for International Student Assessment (PISA)2 is an internationally standardised assessment that was jointly developed by participating countries and administered to 15-year-olds in schools. In terms of reading proficiency, the 2006 survey ranked Australian 15-year-olds at 9th out of 30 in terms of high levels of proficiency, with 35 percent of students achieving Levels 4 and 5. Unfortunately, we seem to have stalled here as this result represents a deterioration in performance since 2000 when 43 percent achieved these levels of proficiency and Australia was ranked 3rd.

A somewhat similar picture of high but declining levels of relative proficiency3 is given by the PISA results on mathematical proficiency. Australian 15-year-olds rank 9th out of 30 in 2006 with an average score of 520, down from 5th position in 2000 when the average score was 533. This is worrying given the importance of mathematics to building strong engineering and other important skill bases for future innovation.

When it comes to interest in learning science, surveys of Australia’s 15-year-olds paint a dismal picture. The PISA 2006 survey4 records an average interest score of just 465, ranking Australians 24th out of the 30 OECD countries. Not having scientifically literate leaders may stall our capacity to solve major technical problems which are affecting Australia and the rest of the world.

1 Gene Tunny, Educational attainment in Australia, Economic Roundup Autumn 2006, Canberra: Commonwealth Treasury.

2 OECD Programme for International Student Assessment (PISA), http://www.pisa.oecd.org/pages/0,2987,en_32252351_32235731_1_1_1_1_1,00.html

3 All scores in a given year are relative to the OECD mean which is set at 500.4 PISA Science Competencies for Tomorrow's World, 2006 http://www.pisa.oecd.org/

document/2/0,3343,en_32252351_32236191_39718850_1_1_1_1,00.html

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Cross-country differences in educational attainment and performance are driven in part by differences in national levels of expenditure. Comparisons of public expenditure at primary, secondary and tertiary levels are shown in Figure 6 for 30 OECD countries.

Figure 6: Public expenditure on education by level, percent of GDP, 2003

percentage of GDP

Primary Secondary Tertiary

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ark

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ay

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Source: OECD Family Database www.oecd.org/els/social/family/database; OECD - Social Policy Division - Directorate of Employment, Labour and Social Affairs

On these comparisons Australia’s public expenditure ranks 19th out of 30 and is slightly below the OECD average in terms of total public expenditure on education as a proportion of GDP. Only in primary education is Australia above average in its rate of public investment. Moreover Australia shows a decline over time in public resources devoted to education, the share declining from 5 percent in 1995 to 4.8 percent by 2004.1

The decline in public investment since 1995 has been offset to some extent by rising private expenditure on education. Nevertheless, the sum of public and private educational expenditures in Australia, amounting to 5.8 percent of GDP in 2004, still lags the OECD weighted average of 6.2 percent.

In summary, our investment in human capital has stalled. Our investment in the educational revolution of the 1970s and 1980s saw a massive increase in the proportion of young people, particularly young women, staying on at school to complete Year 12, and a matching increase in tertiary enrolments. By the mid 1990s Australia was a world leader in educational standards.

1 OECD, Education at a Glance, Table B4.1. 2007

http://www.oecd.org/els/social/family/database

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Since that time, however, public investment in education has declined as a share of GDP, leaving Australia below the OECD average. Over the past decade there has been evidence of declining educational proficiency relative to other OECD economies in both the literacy and numeracy of 15-year-olds.

Investment in R&DThe Productivity Commission1 observed that Australia lags behind leading OECD countries in terms of the resources devoted to research and development (R&D), both in business expenditure and government expenditure, with business expenditure as a proportion of GDP just half of the OECD average. It argues that the performance on business R&D can be explained, at least in part, by the sectoral bias in Australia towards relatively low-tech industries. This observation could, however, be turned the other way around to argue that the sectoral composition of Australian industry is influenced by the low level of R&D expenditure. We think our innovation system should encourage the growth of world’s best knowledge-intensive industries to emulate our achievement in the area of mining technology services.

Whilst R&D is only one input into the innovation process, it is found in many studies to be a significant contributor to productivity growth. The evidence is summarised in Annex 4. This evidence is backed up in the Australian context by the Productivity Commission2.

Non-R&D innovation investmentThe Productivity Commission3 points out that care must be taken in relying on measurable R&D expenditure as a proxy for total national innovation, given that organisational innovation is very important in the service sector but weakly reflected in R&D expenditure, as well as in patents data.

Surveys by the ABS show that non-technological innovation is undertaken by a significantly large number of firms across all industries. This evidence suggests that normal R&D measures significantly understate the amount of innovation occurring, particularly in SMEs. Formal R&D spending accounts for only one third of total business expenditure on innovation. Smith and O’Brien4 however, in their census of Tasmanian firms, found that more than 40 percent of all firms are performing R&D, a figure much higher than indicated in ABS figures.

1 Productivity Commission Research Report, Public Support for Science and Innovation, March 2007.2 Ibid, p6283 ibid4 Keith Smith and Kieran O'Brien, Innovation in Tasmania: An innovation census

in an Australian state. Australian Innovation research Centre. 2008.

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Australian Government support for science and innovation is broader than pure R&D funding, encompassing various government portfolio programs, CSIRO and National Health and Medical Research Council (NHMRC) funding, ARC funding of research, research tax concessions and university research funding. Australia has highly unique assets in its research armoury such as the CSIRO, which is a massive interdisciplinary organisation with tentacles across the continent and the world. But our broad-based support for science and innovation has declined over the past fifteen years, from a high of 0.76 percent of GDP in 1993 to a low of 0.58 percent in 2007 (Figure 1).

The rate of patenting The establishment of patents on products and processes is an approximate measure of inventiveness. Some patents are taken up by innovators, so an increase in the supply of patents can be associated loosely with a rise in innovation. However, great care must be taken in inferring too much about innovation from patents data. Gans and Hayes1 investigate the determinants of OECD countries’ ‘Innovation Output’, which they define as the number of international patents per capita granted by the US Patent and Trademark Office. They find that ‘innovation output’, which is but one of a number of intermediate outputs produced by the innovation system, over the period 1973 to 2004 is associated with a range of variables. These include the primary inputs – R&D expenditures and educational expenditures – as well as variables they had constructed to identify the strength of protection for intellectual property, the clustering of innovation and the quality of linkages between the public and private sectors. Using their results to compute an ‘innovation index’, they report that Australia’s innovative performance was weak in the 1970s in comparison with 23 other OECD countries, placing Australia as a third-tier or imitator economy. Innovative performance improved markedly in the 1980s and 1990s, moving Australia to the second tier of OECD economies alongside the Netherlands, Belgium and the UK. According to their measure, Australia’s innovation performance has plateaued since 1998. They conclude that the sharp improvement in performance which started in the early 1980s was driven largely by increases in R&D expenditure and employment and by improvements in IP protection which outweighed the declining rate of public investment in education. Although a number of reservations can be expressed about such a study, it does concur with other indicators that innovation has slowed over the past decade.

1 Gans, Joshua and Richard Hayes, Assessing Australia’s Innovative Capacity: 2007 Update’, Centre for Ideas and the Economy, Melbourne Business School. 2008. www.mbs.edu/jgans

http://www.mbs.edu/jgans

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Assessingthefinaloutputsofinnovation:productivity and living standardsUltimately we want to know whether the innovation system is delivering benefits to the sustainable living standards of Australians. The prime determinant of living standards is the productivity of labour, measured as the real value of output per hour worked.1

Figure 7 displays the path of real GDP per hour worked for 9 comparator economies and for the OECD as a whole. Australia experienced fairly rapid growth in the productivity of labour throughout the 1990s, when Australian productivity caught up with the OECD average. But OECD productivity has grown faster since 2002. In comparison with the USA, Australian labour productivity was 83 percent in 1980, rising to 88 percent in 1998, slipping to 82 percent by 2007.

Figure 7: GDP per hour worked in selected OECD economies, 1980 to 2007

20

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Finland Australia Germany NZ JapanUSA

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Source: The Conference Board and Groningen Growth and Development Centre, Total Economy Database, January 2008, www.conference-board.org/economics/. via Steve Dowrick.

1 There are problems with this measure in that for many countries, including Australia, the value of non-marketed services such as public education and government is not measured; instead, the value of output is assumed to be the same as the value of the inputs which amounts to an assumption of no productivity growth. Since the public sector has experienced substantial innovation in work practices, particularly though the introduction of new computer and communication technologies, this means that the official figures probably understate the true rate of national productivity growth. A clear example of this problem is in the education sector which has become Australia’s third largest exporter, after coal and iron ore (see: Australia's Export of Education Services, Reserve Bank Bulletin, June 2008. www.rba.gov.au/PublicationsAndResearch/Bulletin/bu_jun08/aus_exports_education_services.html. The way productivity is measured gives little clue that innovation has been taking place in this sector.

http://www.conference-board.org/economics/http://wwwhttp://www

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It is instructive to look at productivity growth in more detail by examining the performance of different sectors of the Australian economy. Hughes and Grinevich 1 highlight the importance of service sector industries for overall economic performance. The three sectors that contributed most to overall productivity growth between 1992 and 2004 are all in the service sector: wholesale trade, communications and finance. Agriculture, construction and transport were also amongst the top ten contributors. This confirms previous findings from the Productivity Commission that service sector innovation has been vital for growth in the whole economy over the past few decades. It also raised questions: Is our innovation system tuned in to services? Are we taking advantage of Australia’s lead position in services in global trade?

So far we have examined the growth of the productivity of labour. This is not a direct measure of the contribution of innovation because it includes the contribution of capital investment whereby the workforce is enabled to produce more because they have more machinery and equipment to work with. If the contribution of capital is excluded, the resulting measure of ‘multi-factor’ productivity provides a better indication of the contribution of innovation. The most recent ABS estimates of this measure are illustrated in Figure 8 for the market sector of the Australian economy.

Figure 8: Multi-factor productivity in the market sector 1964/65 to 2006/07

4.0

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y = 0.0124x + 4.0885R² = 0.9767

1964/65 1969/70 1974/75 1979/80 1984/85 1989/90 1994/95 1999/00 2004/05

ote: The labour input is measured as hours worked in the market sector.ource: Australian System of National Accounts, ABS Cat. 5204.0, Canberra.

NS

1 Alan Hughes and Vadim Grinevich, The Contribution of Services and Other Sectors to Australian Productivity Growth 1980-2004 (Report prepared for the Australian Business Foundation), Cambridge, UK: Centre for Business Research. 2007.

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The bold line in the figure traces the path of multi-factor productivity since 1964. The dashed straight line represents the long-run trend rate of growth, 1.24 percent per year.1 There was a long period of sustained and rapid productivity growth, averaging 1.7 percent per year, between 1991-02 and 2002-03. This miracle growth has, however, stalled since 2003. No multi-factor productivity growth has occurred in the market sector since 2003.

This collapse in productivity growth might be taken as an indication that innovative activity has ceased but an examination of sectoral trends reveals a more complex picture. Since 2003 there has been continued growth in multifactor productivity in several sectors, including communications, transport and finance. This growth has been offset by productivity decline in mining (since 2000), in agriculture (since 2005), and in electricity, gas & water (since 1997).

In the case of agriculture, the collapse in productivity can be attributed to drought rather than any lack of innovation capacity. The collapse in productivity in mining is more complex. This sector is the source of most of Australia’s rising terms of trade. The huge rise in the world prices for minerals has led to sharp increases in both capital investment (the capital stock has risen by 34 percent since 2000-01) and employment of labour (hours worked have risen by 68 percent). Opening new mines involves a long delay, and in the short-term the exploitation of previously marginal mines inevitably involves decreasing returns. The 25 percent fall in mining productivity since 2000 is almost certainly due to these special factors which have nothing to do with the underlying rate of innovation in the industry. Consideration of these special sectoral factors leads to a conclusion that whilst the rate of innovation-led productivity growth has slowed since the miracle growth rates of the 1990s, innovation has not ceased.

1 The vertical scale is in logarithmic units. This means that a straight line represents a constant proportional rate of growth and that the steeper the upward slope of the productivity line, the faster is the rate of productivity growth.

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We turn next to Australian performance in living standards and well-being. A common measure of living standards is GDP per capita. It is far from a perfect measure because it excludes the value of leisure and household production, but data is available for most countries for long periods so it provides a consistent, if imperfect, measuring stick. Figure 9 displays these data for selected OECD countries.

Figure 9: GDP per capita in selected OECD Economies, 1980 to 2007.

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Finland Australia Germany NZ UK JapanUSA

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1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

Source: The Conference Board and Groningen Growth and Development Centre, Total Economy Database, January 2008, www.conference-board.org/economics/. Via Steve Dowrick (2008).

In terms of real income per person, Australia has risen substantially above the OECD average since the mid-1980s. Starting in 1980 at 81 percent of US levels, Australia had improved by 2007 to 84 percent. The continuing rise in Australia’s real income over the past few years, at a time when productivity growth has stalled, is due to the massive 40 percent improvement in the terms of trade over the past five years – a phenomenon that cannot be taken for granted to continue in the longer term.

The final measure of well-being discussed in this section is environmental quality and sustainability. Here the picture is rather bleaker. The State of the Environment Report 20061 covers many areas of environment concern affecting Australia. The report explains that salinity is

1 Australian State of the Environment Committee, Australian State of the Environment - Independent report to the Australian Government Minister for the Environment and Heritage, 2006

http://www.conference-board.org/economics

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occurring in about one-third of catchments assessed, particularly in south-western Australia, and in the southern Murray-Darling Basin. These are all areas with a long history of land clearing and intensive agricultural use. Reductions in the area of perennial native vegetation in these catchments have altered the surface and groundwater hydrology, increased groundwater recharge, and increased salt ingress to rivers and streams. Approximately 5.7 million hectares are within regions mapped to be at risk of or affected by dry-land salinity. At the same time, Australia has eminent research organisations which have developed and continue to provide innovative solutions to environmental problems, such as CSIRO and 11 environmental Cooperative Research Centres. These bodies turn Australia’s science into successful new products, services and technologies.

Overall assessment of Australia’s innovation record Australian innovation seems to have slowed or even stalled in the new millennium. Strong productivity growth in the decade of the 1990s has given way to significantly slower growth since 2003. Strong growth in average real income over the past five years appears to have been driven more by a massive improvement in the terms of trade rather than by innovation.

The productivity success of the 1990s was built on successful innovations occurring in agriculture and throughout the service industries, particularly in wholesale trade, communications and finance. The success appears to have been based on the adoption and adaptation of new computer and communication technologies by service oriented industries. The successful adoption of new technology and new processes was made possible by the strong rise in educational achievement that had occurred over the previous decades.

The cause of the productivity slowdown is uncertain. However, our analysis of the primary and intermediate inputs into the Australian national innovation system points to several factors.

The education revolution of the 1970s and 1980s saw a massive influx •of young Australians, particularly girls, into Year 12 education and then on to tertiary education. These well-educated young people entered the workforce in the 1990s, quickly became computer literate and were instrumental in implementing the innovation surge of that decade.

A declining rate of public investment in education over the past •decade has stalled the rate of increase in educational attainment. Relative proficiency in literacy and mathematics amongst our 15-year-olds is in decline and interest in science is alarmingly low.

Public investment in research has declined since 1995 with •university funding for research falling further behind the full-cost

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of conducting that research and government research agencies such as the CSIRO suffering successive funding cutbacks.

The vastly improved terms of trade, although a strong •contributor to rising GDP per person, has been associated with a significant strengthening of the Australian dollar. This has made it difficult for non-resource sector exporters, with adverse effects on investments in imported capital goods that embody technological improvements and facilitate both process and product innovations. The ‘Resource Curse’ (or ‘Dutch Disease’) may have become relevant since 2003 with attendant effects on innovation and productivity growth.

Slowdown in productivity growth over the past five years is of major concern because rising terms of trade cannot be relied on to continue sustaining real income growth indefinitely. Although there is little prospect that the demand for Australia’s natural resources will decline in the foreseeable future, the prices of natural resources could fall back significantly, reversing the terms of trade position. This would, most likely, be followed by a devaluation of the Australian dollar. However, exporting industries would not be able to take advantage of this unless there was a capacity to do so. Such a capacity can only come from a stock of human capital and through cumulative innovations in the provision of new processes and products. However, it can take decades, rather than years to build such capacity. Falling behind because of a lack innovation presents problems for our economy and its capacity to export. Our industries now compete in a world where innovation is taking place more widely, even in what are perceived to be underdeveloped countries. So we cannot afford to allow the resource boom to remove our competitiveness in non-resource industries. We must create conditions where our capacity to absorb overseas innovations and to develop our own innovations, in appropriate niche areas, is promoted vigorously.

The challenge now is to re-invigorate innovative activity, leading to renewed growth in productivity and living standards and an enhanced Australian capacity to deal effectively with major environmental and climactic challenges. These great challenges cannot be met unless our economy is strong and stable. Australia has proven in the past that it can be innovative and productive enough to solve major problems. Fortunately, we have both the resources and the necessary capability to meet these new challenges. All we need is the collective will to enact an ambitious and effective innovation strategy to prepare us for the future.

the national innovation system

Innovation is a term in danger of being over-worked and over-hyped. Words matter, because the precision or otherwise of the terminology we use affects the clarity of policy intent and focus.

Innovation is not the same as invention and innovation policy is more than just science and technology policy. Trawling English dictionaries highlights some clear and useful semantic distinctions. These distinctions help to position the necessary preconditions for innovation – a pool of ideas and talent – and the necessary circumstances for innovations to establish themselves successfully within a marketplace. Much innovation fails to go anywhere, because effective paths to market and user approbation fail to materialise.

Innovation is commonly described as ‘creating value by doing things differently’ or ‘creating value through doing something in a novel way’. A simple version is ‘good ideas put to work’. From this viewpoint, however, the incidence and value of innovation can only be established after the event.

To influence innovative outcomes we need an active appreciation of the dynamic processes associated with innovation that lead to change. Thus we can describe innovating and being innovative as the processes of creative problem solving or solution seeking – designed to produce practical outcomes. The outcome of these processes is the introduction of novel solutions to real problems, needs or opportunities.

Innovation largely revolves around what happens in businesses. Ideally, the best practices and lessons spill over into the non-market sector, especially into government or community service delivery, but it is the productivity from innovation in business that provides the resources to fund these public services.

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Hence the pivotal crucible for innovation is the entrepreneurial activity of deploying new ideas or inventions within the marketplace. It is not enough to just introduce something new. To be successful, the novel product or service must attract the support of customers and end users, either displacing previous solutions or providing the means to do something not previously possible. Innovators succeed when what they do translates into increased productivity or out-competes others for the hearts or wallets of customers and other beneficiaries.

Innovations can be classified usefully along a variety of dimensions:

process vs product:• Process innovations reduce the costs of producing and delivering a given good or service (a product), while product innovations improve the qualities of existing products or provide new products to be offered to consumers.

radical vs incremental:• Radical innovations lead to fundamental changes in processes or products, while incremental innovations involve adaptations of a core innovation in particular applications.

technological vs organisational:• Technological innovations are generally embodied in equipment used by labour, while organisational innovations involve the organisation and reorganisation of groups of people into effective teams in the production and delivery of goods and services.

science-led vs customer-driven: • Science-led innovations are an outcome of scientific research both in the public and private sectors, while customer-driven innovation is built upon careful market research and user interaction.

Examples of these different categories of innovation are provided in Table 1. In practice many innovations will cross between several dimensions.

Table 1: Categories of innovation

Product Innovation Process Innovation

Science-Led Customer-Driven Technological Organisational

Radical Solar Panel Water Heating Internet Search EnginesGenetically Modified Crops

Toyota’s Total Quality Management

Incremental More efficient or cheaper solar panels Home- delivered pizzasReducing evaporation in irrigation systems

A more efficient pay or bonus system.

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The entrepreneur is the key organiser and agent within the innovation system. The entrepreneur does not, however, operate within a vacuum and it is the context within which the entrepreneur acts which forces us to think about an innovation system.1 The entrepreneur depends on the backdrop of an education and research system that accumulates and generates both knowledge and ideas and produces talented and creative people. These are crucial prerequisites for an innovative culture. Entrepreneurs also rely on a community of users who are equipped and motivated to think about adopting new product or service offerings. Potential beneficiaries of innovations need to have the means to access and assess the value of competing product and service offerings, and the competencies to be able to use and exploit them.

There are, therefore, three highly interdependent functions within an innovation system:

the origination of new knowledge and ideas: • knowledge production;

the deployment of ideas within a real world context: •entrepreneurial knowledge application; and

the diffusion and adoption of this applied knowledge and its •adaptation in use: knowledge diffusion and absorption.

Figure 10: Innovation is a dynamic, evolving and learning process

KNOWLEDGEPRODUCTION

KNOWLEDGEAPPLICATION

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Policies for a robust national

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Source: Terry Cutler (2008)

These elements combine to form a virtuous and open-ended cycle of learning and responsiveness to new challenges and possible solutions. This dynamic is illustrated in the following representation of the systemic elements of the innovation process (Figure 10).

1 The development of the concept of National Innovation Systems is examined in Mytelka, L. K. and Smith, K., Policy learning and innovation theory: an interactive and co-evolving process, Research Policy 31, 2002, who highlight the earlier work of Freeman, Lundvall and Nelson.

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In making these distinctions between discrete elements of an innovation system we can also see their interconnectedness, and it is these relationships that need to be understood in determining what makes for a robust national innovation system.

Innovation is built on stocks of knowledge and capability, and the information flows of the innovation capital around these (see Table 2). We need to invest in the capabilities required around each element of the innovation system, as well as investing in the linkages and flows between them.

Table2:Innovationstocksandflows

Stocks Flows

Human capital Social networks

Institutions Trusted transactions

Facilities (plant and equipment)Fitness for purpose; access and operability

Information and dataAccess; freedoms to use and adapt

The final element shaping innovation systems is government’s influence on market design through regulatory and framework conditions.

All this gives rise to a complex matrix of activities underpinning a nation’s innovation capability, and a highly diverse field of interested contributors. We need to ensure that we have the right stocks of capability. But we also need to secure the widest and most diverse pool of talented institutions and people who are empowered to participate in the innovation agenda. A national strategy for developing an innovative culture needs policies that are inclusive, not exclusionary.

Although public policy for promoting innovation must be focused on the competitiveness of our firms within global markets, innovation is also a crucial factor in the production and delivery of public goods. This creates a triple bottom line for national innovation policies arising from:

firm and industry innovation, and market changes to •increase productivity and improve competitiveness;

innovations and changes in public policies and service •delivery around the production of public goods; and

innovations and changes to address societal and environmental •aspirations and challenges through mobilising private and public sector capabilities relating to these challenges.

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Thus the pursuit of innovation involves change processes within a societal or community context. It is about promoting purposeful and meaningful change inside this complex system. This engages both the private and public sectors, and the way in which they work together.

Government has a central interest in a robust innovation system because such a system is a public good in its own right. Similarly, government has a stake in promoting the pursuit of innovation within the private sector where such activity enhances the national good. Moreover, it behoves government to be innovative in the conduct of its own affairs and in the delivery of public services.

A national innovation system incorporates regional and sectoral clusters of activity. This is why the Review examined the relative roles of the Australian Government and our States and Territories within the innovation system. Within a globalised economy, a national innovation system also needs to be positioned within a global innovation ‘ecosystem’. How we best internationalise our innovation system and capabilities is a fundamental challenge.

As a small, albeit wealthy, country we have a pressing need to engage effectively with the rest of the world. Increasingly we are facing global rather than local challenges, with climate change being the obvious example. These challenges will have local impacts of course but the solutions are likely to have global applications – providing us with both a need to find innovative solutions and the opportunity to create wealth from those solutions.

Australian economic development has been deeply defined by our economic geography as a relatively small economy on a remote island continent. We have been subject to both the tyranny of distance, within the country and with major trading partners, and a compounding tyranny of low density, with a small population occupying the world’s sixth largest country land mass. This is both a challenge and a source of advantage, as these challenges are not unique to Australia and have required us to develop solutions to problems that we can sell to the rest of the world.

These circumstances together with an abundance of natural resources, both minerals and agriculture, has led to a strong dependence on resources based industries, especially in relation to exports, and an inclination in the past to rely disproportionately on local products and markets.

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The internationalisation of the Australian economy by the Hawke Government after 1983 was a break point in Australia’s economic history. Twenty-five years on we need a similar major breakthrough with the global integration of our innovation systems. Today we need innovation policies geared to a rapidly changing global environment.

This is a priority matter for a relatively small and geographically challenged country like Australia. Australia’s share of world R&D expenditure is small at 1.3 percent as is our share of new knowledge and innovation each year at approximately 2 percent. While this is a credible performance it means that 98 percent is created elsewhere and it is essential that we are able to access it or risk being overtaken by those that do. The quality of the 2 percent that we produce and its usefulness to the rest of the world will be important determinants in our ability to access the other 98 percent.

Figure 11: Estimated R&D expenditures and share of world total, by region: 2002

Africa$5 (0.6%)

Europe$234 (28.7%) Asia

$246 (30.2%)North America$300 (36.8%)

South AmericaCarribean$18 (2.2%)

Oceania$9 (1.3%)

World total = $813

Note: R&D estimates from 91 countries in billions of purchasing power parity dollars. Percentages may not add to 100 because of rounding.Sources: Organisation for Economic Co-operation and Development, Main Science and Technology Indicators (2006); Ibero-American Network of Science and Technology Indicators, http://www.ricyt.edu.ar, accessed 5 March 2007; and United Nations Educational, Scientific and Cultural Organization (UNESCO), Institute for Statistics, http://www.uia.unesco.org.

As a small investor in R&D by international standards, Australia is dependent on the global community for much of the technology that underpins our economic competitiveness and improved living standards. Without contributions to the rest of the world from its own science base and without strong international linkages to keep in touch with developments at the leading edge of research and technology, Australia runs the risk of

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becoming a technological ‘price taker’1. Without deep mutual links with the global innovation system, Australia could be at risk of being denied effective access to technologies critical to our defence, competitiveness and welfare requirements.

It is essential therefore that we think globally in all aspects of the innovation system, through talent and mobility, through enterprise linkages, and through institutional linkages and infrastructure.

In approaching this challenge, we must recognise the realities of Australia’s position, in particular that we are small and remote, but also that we have considerable attractions. As a nation we are wealthy and smart enough to be interesting without being so large as to be a threat. We are located in the fastest growing region of the world and have global strengths in a number of fields, but by no means all. Australia is consistently rated as one of the most desirable places to live, especially by highly skilled knowledge workers who are critical to the innovation system. We should therefore be an interesting partner.

There are a number of trends currently shaping the nature of global innovation. These trends and the internationalisation of innovation provide both challenges and opportunities for Australia:

Global talent is more mobile than ever before and advances •in science and technology are now being sourced from all corners of the globe. Increasingly countries are recognising that brain circulation is an important goal for a vibrant innovation system, rather than focussing simplistically on just brain drain or brain gain. Nonetheless, Australia should aim for a net inflow of talent.

Through• advances in ICT and efficiencies in production and logistics, global supply chains are becoming more disaggregated and open to greater competition. A country which understands and specialises on specific parts of the supply chain can grow in competitiveness and gain access to new markets.

Global scale engagement to address ‘big science’ questions •requires facilities and intellectual resources beyond the scope of most countries, and in particular a relatively small country like Australia. A direct influence on international collaboration in this and coming decades will be the costs associated with building research infrastructure and conducting

1 The Allen Consulting Group, A Study of International Science and Technology Policies and Programs. 2003

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experiments which address globally important and forefront science with large multidisciplinary and distributed teams.

The world community is pooling investment in problems •that affect all parts of the planet and require a coordinated solution. Most commonly these relate to the monitoring of, and research on, the health of populations and the health of the planet (such as the observation of the oceans and atmosphere and to monitor climate change).

Australia is currently bidding to host the Square Kilometre •Array (SKA), an eighteen country, €1.0 billion project to build the world’s most sensitive telescope capable of exploring the origins of the universe. This funding level is beyond the scope of most individual national science budgets for single endeavours over the 10-20 year period required for the design, construction and exploitation of new facilities.

Along with the opportunities for engagement in international innovation networks is the potential erosion of capacity for home-based research and innovation through international off-shoring and outsourcing abroad. The movement of key talent overseas and the loss of critical mass in strategic disciplines also need to be addressed in Australia’s response to the internationalisation of innovation.

In order to benefit from these opportunities and ensure that Australia is not left behind in the global innovation environment, Australia must undertake a step change in its approach to the internationalisation of its innovation systems. The default position for innovation policy should be one of removing existing constraints in order to allow, facilitate and encourage international engagement, collaboration and information flows.

There is already considerable activity in this area internationally. Numerous countries have articulated international innovation strategies. They include:

The United Kingdom’s strategy for international engagement• 1 which focuses on the movement of human resources, the attraction of foreign investment in R&D and linking of the innovation and foreign aid and development agendas.

European countries such as Germany, the Netherlands and Finland •which are explicitly recognising the importance of international collaboration in their national innovation policies2. The EU

1 Global Science and Innovation Forum, A Strategy for International Engagement in Research and Development, United Kingdom Department of Trade and Industry, United Kingdom, 2006 www.berr.gov.uk/files/file34726.pdf.

2 See for example Ministry for Economic Affairs, Science, Technology and Innovation in the Netherlands: Policies, Facts and Figures. 2006. www.minocw.nl/documenten/Science-Technology-Innovation-brochure-2006.pdf ; Finnish Ministry of Employment and the Economy, Finland’s National Innovation Strategy, 2008. www.tem.fi/?l=en&s=2411.

http://www.berr.gov.uk/files/file34726.pdfhttp://http://http://

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Framework Program, by design an international innovation program, is encouraging more international cooperation with countries outside of Europe through people exchanges and building capacity through the International Scientific Cooperation Activities program1.

Asian economies such as Korea have explicit strategies to •internationalise their innovation systems through explicitly targeted international collaboration2 and many emerging economies such as China and India are also looking to enhance their international collaborations, with inward foreign direct investment (FDI) increasingly targeting research operations3.

It is important that Australia moves now to position itself in the international innovation system. Global connections need to be created, supported by active policy mechanisms, across a range of levels:

Internationalisation through talent and mobility: •attracting talent to Australia and encouraging a culture of internationally connected researchers and entrepreneurs.

Internationalisation through business and enterprise: •enhancing inward and outward foreign direct investment in innovation and ensuring that Australian firms are integrated within global supply chains.

Internationalisation through institutions and infrastructure: •encouraging the internationalisation of Australia’s publicly funded institutions through measures and programs to enhance collaboration, share knowledge and to ensure access to foreign innovation networks.

With a relatively small but well-connected innovation capability, Australia stands to gain significantly by developing more structured and strategic links with the global community.

1 European Union European Union Framework Programme 7, 2008. http://cordis.europa.eu/fp7/public_en.html 2 Korea Institute of Science & Technology Evaluation and Planning, 2007, http://www.kistep.re.kr/index.jsp 3 OECD, OECD Review of the Chinese Innovation System, p32. 2006

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http://cordis.europa.eu/fp7/public_en.htmlhttp://www.kistep.re.kr/index.jsp

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innovation in business

Making business innovation a priority

“Innovation is critical to Australia’s national future. Our prosperity, our economic strength and our ability to compete in the global economy all depend on valuing innovation, harnessing its potential and putting it to work for the benefit of all Australians… In particular, we need to find ways to increase innovation performance across the economy, to ensure business has better access to new ideas and new technologies and to bridge the divide between industry and research…

In today’s economy, innovation policy is industry policy.”

Senator the Hon Kim Carr, 22 January 2008, announcing the Review of Australia’s National Innovation System

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Finding the hidden realities of innovationInnovation is more widespread than is often imagined, occurring everyday in the way business enterprises operate, meet the needs of customers, and organise their people and processes. This is not traditional science and research-led innovation. It is the non-technological innovation that occurs and transforms businesses as they engage with their customers and markets.

This market-facing business innovation is often overlooked and undervalued. But if it is ignored, Australia squanders an opportunity to make the productivity gains we need to maintain our prosperity and living standards.

This challenge is well recognised in the UK where th